Wednesday, September 09, 2009

Lampert Speaks…But Where’s His General Grant?

There were, until the financial crisis, two main schools of thought on Sears Holdings in the hedge fund community.

One school consisted of those hedge funds that made early, and profitable, bets that Eddie Lampert would turn Sears into a Berkshire Hathaway of the new millennium.This school held the view that there was enormous value in Sears; that Eddie Lampert would find a way to unlock that value; that short-term earnings were meaningless; and that anyone who focused on the dilapidated nature of Sears (and K-Mart’s) stores; on the aging and coupon-clutching customer base; and the resulting, lousy comp-store sales, was missing the vast potential in Sears’ real estate portfolio.

Students of this school never actually shopped at Sears, although they may have visited the stores once in a while—like when Eddie launched a new initiative, for example (see “Wal-Mart 9, Sears Holdings Corp 2” from June 30, 2005). And they probably wouldn’t have been caught dead in a K-Mart.

But they made a lot of money in the stock.

The other school of thought on Sears Holdings consisted of hedge funds which, for the most part, had invested in retailers over the years; knew a good store from a bad store when they saw it; and couldn’t believe the gap between what they saw with their own eyes whenever they walked into a Sears or a K-Mart versus what Sears’ hyperventilating stock price was suggesting might be going on inside those stores.

That school of thought was short Sears’ stock—and quite painfully, for several years.

Then Lehman came along, consumer spending collapsed, and the Great Leveling began in American business, separating good companies from the bad, retailers included.

And Sears Holdings especially.

Even the imprimatur of the great Eddie Lampert —and we do mean ‘great,’ with not a bit of sarcasm—combined with a billion dollars worth of share repurchases, could not hold up the stock.

Of course, as the crisis took hold and the formerly unprofitable school of thought that regarded Sears as a deteriorating pile of rotting stores—Eddie Lampert or no Eddie Lampert—began to take hold, well, the piling-on began by Wall Street’s Finest and the fickle press.

Even Barron’s—which had once published a $300-plus a share value for the business—recently jumped in, with a cover story titled “Washed Out.”

Thus it was that this weekend, in an uncharacteristic move, Lampert himself finally spoke out, in a public letter to the pilers-on at Barron’s, defending his company:

To the Editor:The Barron's Aug. 24 article that discusses Sears and ESL Partners was misleading, inaccurate, and poorly researched. Without responding to each inaccuracy, I want to correct some of the more important misstatements and address the overall negative bias in the presentation of facts.

What exactly did Barron’s say to provoke the unusual response from the famously secretive, non-blog-publishing hedge fund manager?

Barron’s merely:

a) Recapped the bad news that has come out under the ticker “SHLD” recently—lousy sales, shuttered stores, and uncharacteristically dour reports by Wall Street’s Finest—and;

b) Called out the use of one-time “special charges” and reliance on “Adjusted EBITDA”—a notoriously misleading measure of business health in a capital-intensive business like department store retailing—as a performance metric, and;

c) Speculated that Lampert and his investors are “backed into a blind alley” with “no escape,” thanks to cost-cutting that “has been so extreme,” according to Barron’s, “that it can no longer generate the cash flow to mount a turnaround”—a legitimate concern given that the balance sheet was cleared of $5 billion in cash spent on share buybacks from 2005 to 2008 at stock prices well above the current price—and;

d) Predicted “Sears stock could fall by as much as 50% as the problems drag on,” and;

3) Declared that “The agonies of Sears are of vital importance to the investors in Lampert's hedge fund,” suggesting gruesome consequences for the hedge fund king.

So how did that hedge fund king respond to Barron’s?

Quite lamely, we think.

While first admitting “the performance of the company is not where I would like it to be,” Lampert writes:

“The executive team and associates of Sears have all been hard at work in attempting to change this performance in an environment that has been less than friendly to the entire retail industry. At the same time, contrary to the theme of the article, we have made some important progress in 2009.”

The first sign of progress, according to Lampert, is an amended credit facility. We do not make this up.

To healthy retailers, of course, an amended credit facility is not so much a sign of “progress” as a sign the company won’t be filing Chapter 11 any time soon. We think it should be dismissed out of hand as filler.

The second sign of progress, Lampert says, was an increase in “adjusted Ebitda” of 9% in the first six months of 2009, when “most of our major competitors saw a decrease in their Ebitda performance.”

Unfortunately, this assertion that Sears outperformed peers in one measure of its fundamentals is hard to refute without exact knowledge of a) who Lampert considers to be Sears’ “major competitors,” and b) what goes into Lampert’s own calculations of “Adjusted Ebitda.”

According to our Bloomberg, for example, Sears’ EBITDA in the first half of the current year did not grow: it declined, to $465 million from $636 million the previous year.

Furthermore, Wal-Mart, which has been taking market share from Sears almost since the day Sam Walton opened his first store, and certainly has to be Lampert’s company’s single most important “major competitor,” did not show an EBITDA decrease during the first half of the current year—it showed a slight increase.

Worse, for Lampert anyway, is that while Sears was bleeding $162 million of negative cash flow from operations in that same period, and spending a bit under $200 million on top of that for capital spending, Wal-Mart was gushing $13.469 billion in positive cash flow, and spending $9 billion—yes, $9 billion—of that money on new stores, new fixtures, and new technology...i.e. the very stuff that has made Wal-Mart what it is today: Eddie Lampert’s worst nightmare.

Moving on to the third of Lampert’s “signs of progress”—and we aren’t making this one up, either—the Sears Chairman points out that Sears stock jumped 70% year-to-date, “outperforming all of our large competitors.”

Besides being absolutely meaningless—short-term stock price moves tell an outsider precisely nothing about the long-term health of a business—this data point, like Lampert’s EBITDA calculation, looks far less impressive when you move the goalposts back to the end zone, where they were before he shifted them to a better-looking spot on the field.

Lampert surely knows—he does run one of the most successful hedge funds in America—that in almost any stock market rally of the type we’ve enjoyed thus far in 2009 (i.e. the sharp, short-covering-off-a-panic-low variety), the lowest quality stocks always move up the furthest, for the simple reason that they already moved down the furthest.

Just ask the short-sellers in AIG.

More telling to the underlying business than a short-term dead-cat stock bounce, of course, is a time-frame that encompasses the entire financial crisis. Had Lampert chosen to brag about the last twelve months, in that case, the comparison wouldn’t look so perky: Wal-Mart, Target and Costco shares were recently down 15 to 20% over that timeframe.

Sears was down 31%.

“Okay, wise-guy,” the discriminating reader might say (and we have very discriminating readers here at NotMakingThisUp), “what would you do with Sears that the great Eddie Lampert is not?”

The answer to that is easier said than done, but the turnaround of any institution as large and storied as Sears has nothing to do with short-term moves in stock price, “adjusted EBITDA” or amended credit facilities.

Rather, it is about something Lampert did not address in his letter—not even once. It is about one person.

The person who runs the business.

And by way of explaining what we mean by that, we harken back to a simpler but more dangerous time, just 22 years before the 1886 founding of the R.W. Sears Watch Company in Minneapolis: the American Civil War.

During that Civil War (or the War Between the States, if you prefer), the North had suffered a series of overcautious generals, most of them with political ambitions, who could not bring themselves to fight until pushed into battle by the inexperienced Commander in Chief (Abraham Lincoln) and his incompetent General-in-Chief (Henry Halleck).

The end result was, in all cases but Antietam (or Sharpsburg, if you prefer that), disaster for the Northern Army of the Potomac.

It wasn’t until Lincoln finally selected Ulysses S. Grant—a fighter without political ambitions who had captured Vicksburg following one of the riskiest and most underrated maneuvers of the war—as his General-in-Chief, and gave Grant complete control over all Northern armies in the field, that the tide shifted to such an extent that Confederate General Robert E. Lee—the best general the U.S. ever produced—was eventually forced to concede to Grant at Appomattox.

And in much the same way that Lincoln and Halleck tinkered aimlessly until that war had almost been lost (or won, if you prefer that) before turning everything over to General Grant, Eddie Lampert, in all his years as Chairman of Sears Holdings, seems to have avoided making any single individual responsible for the retail battles being fought every day in the real world—i.e. in the communities where shoppers right now are making up their minds whether to go to a Sears, or a Wal-Mart, or a Costco.

But that’s exactly what Sears Holdings needs: it needs a General Grant.

The content contained in this blog represents only the opinions of Mr. Matthews.Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

27 comments:

Anonymous
said...

Jeff-First time poster/long-time reader. While your pieces are always cogent, I found this to be one of your best. Reminded me of Bob Rodriguez of FPA who, when in college asked Charlie Munger for his advice on what to do differently to achieve investing success. Munger replied "Read history, read history, read history." Thanks.

Jeff - Long term reader; first time commentator. I agree whole heartedly with your comment - soemtimes it seems ESL is going out of its way to make the shopping experience at K Mart miserable. There's a K Mart conveiently located very close to my house, but the deterioration in the physical store, the poor selection of inventory, the minimal number of registers open and the poorly trained and motivated staff always make me think twice about going in.

Sears needs more than Grant. It needs a high energy, passionate retailer. Someone who loves walking up and down the aisles of stores and greets customers. An executive who knows that the customer in Frisco, TX is very different from the one in San Francisco and why. It does not need Lambert and his "adjusted EBITDA" financial statement nonsense.

Sears is doomed. They have one or two solid product lines -- Craftsman and Kenmore -- and the rest is disposable. All the cost-cutting has taken a toll.

I went to the local Sears to buy a new ratchet and some sockets and it took 15 minutes to find a completely disinterested and surly adolescent to unlock the display case. Craftsman tools are excellent, but I'm concerned that the brand may not survive, or be ruined by Chinatization (nearly all Craftsman hand tools are made in USA, though they have a Chinese Craftsman-Lite brand I forget the name of it).

Yo Jeff,Fantastic write! Just a few points to add:1. No mention by Lampert of Sales or Revenue. Hard to have profit without those.2. Note he emphasizes Sears Holdings less than 50% of ESL--preparing to dump it?3. Forget Grant--he needs a Sherman who cuts loose from the railroad(logisitics) and burns a path through the weak unprotected retail underbelly to the sea of consumers ignored by Walmart/Target/Macys et. al.4. Lampert mentioned Breakthrough Imperative in at least two conference calls in last two years, yet apparently has not applied the lessons. Build off the niche, challenge market share.5. The niche for Sears is 29% of the appliance market...Home Depot and Lowes are in the teens, and Best Buy under 7%. Obama Incentive package has appliance rebates coming this fall--Position to take advantage!6. Breakthrough Imperative challenged the Long Tail, but Lampert's web initatives are to add more skus to an overloaded unwieldy and hackable site, and to offer a weak Gofer program. Dump them, take web in different direction, exclusivity, appliance help, etc.7. Military initatives(gift program, 1st division branding) can reposition Sears to claim patriotic appeal as America's store. 8. Rebuild Kmart--sales increased there last year vs Sears, perhaps due to economy and layaway, but whatever the reason, rebuild the image and the stores(most are dumps).9. Logistics baby--cut costs as Lampert loves to do by reducing the duplicity of the Sears/Kmart logistics system that is huge cost burning after 4 1/2 years since merger. Where are the synergies and cost benefits of the merger?10. Hire Jeff as CEO!

I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.

Let me pick a nit--Grant didn't take over the Army of the Potomac until after it had won its greatest victory at Gettysburg, although that battle, like Antietam, was strategically defensive. Also, to continue with your analogy, Sears fighting Wal-Mart is more like the Confederacy than the Union--fewer resources, less manpower, and less time to win. Sears really needs a Stonewall Jackson. . .

More than the American Civil War I think that the debate on SHLD is more akin to that between the evolutionists and creationists with neither one seeing the other side's case. The bulls tell you that the story is real estate, the bears that the problem is retail, so let's assume the story is both. What I can't understand is why the great Eddie Lampart- I too think he is still one of the greats, doesn't tackle both sides of the story. Get a great retailer in and finance him with store sales. Analysts will talk about unlocking value and metrics should improve, and if it doesn't work then just unload shares or sell off the assets.

Grant was indeed taking Vicksburg around the time Meade was letting Lee's army prepare its escape from Gettysburg. And certainly anybody taking control of Sears would be more in the position of Confederate armies than the Northern armies--short on resources and time.

Still, while I like your Stonewall Jackson notion--he's a great role model for investors, being the ultimate contrarian--Jackson wasn't a commander like Lee.

The basic problem with Sears is a lack of an experienced leader with full control over all aspects of the business. You can't run a great company--or win a war--by committee.

The general Lambert needs is somebody like retailing legend Gordon Segal, founder of Crate&Barrel.

He knows retail, knows how to source creative, compelling merchandise, knows how to train retail associates by instilling dignity and pride in their work--and built a $1-billion-dollar chain of stores essentially by himself from nothing.

Here is the problem with your take on Sears Mr. Mathews: First, Wallmart and Sears are apples and oranges. For example, if I want a refrigerator, I'm going to Sears--Wallmart doesn't carry appliances. That is a big difference. Second--I am a mechanic, professional--if I need tools it's either breaking the bank at the Snap-on truck or Craftsman, which is more than suitable for most of my common needs. Apparently you know little about my type of profession--Sears automotive is good for batteries and maybe tires--they don't carry parts. Autozone is okay for parts, but their tools selection is bunk, and is not their business focus. I break a Craftsman wrench or ratchet, and Sears replaces it for free. Now I'm not saying that the more common retail items like bedding and clothing aren't valid points of comparison, and yes, Sears is a pain for such items, but if I want a window a/c unit, I'm off to sears. My point is this, Sears is a bigger ticket item store than Wallmart, and a better analyst observation might be that Sears should focus on that market. And of Wallmart... Wallmart would be the last place I'd go for substantial items that I would want to last. Wallmart carries disposable, cheap junk. And if you ever do decide to actually research the matter, Wallmart stores stink--50 check out isles but only 3 open, trash and spilled merchandise everywhere, shopping carts all over the parking lot, sales people who don't make enough to care, and well, a bunch of really creepy, mannerless people crowding the isles. Is Sears better? Yeah, but sadly, that's their problem--they lack the trailer trash appeal. Just sayin'...

Last week, a Sears representative was knocking on doors around my neighborhood to see if anyone wanted free estimates for appliance repairs in an apparent attempt to drum up business. I asked the representative if he was made to do this because Sears had just reported a terrible quarter, to which he responded to in the affirmative and that he was trying to save his job. This would appear to suggest that things are so bad at Sears that they have a need to resort to such desperate sales tactics.

There is also a Sears store located in Landover, MD just outside of Fedex Field where the Redskins play. The Sears unit was formerly attached to Landover Mall, until that mall was recently demolished. The Sears store stands all by itself now as the only building in what is a large deserted lot where a mall once stood. I highly recommend looking it up on Google Maps.

Well done article! I enjoyed reading your thoughts on where Sears is at.

I spent 4 years working for Sears. 2 and 1/2 of those were when Mr. Lambert bought out the company. I can attest, first hand, to the immediate loss of passion and excitement within the stores. They were already struggling and it got worse real fast. We didn't have enough staff to keep up with merchandise resets and sales, our pay was decreased, and the items/services we stood behind on the sales floor decreased dramatically in quality.

The worst of it was, if an item needed repair, the repair never happened--and not just regarding merchandise sold to customers. If lights failed, they weren't changed quickly. It was cold in the winter and hot in the summer. Customers complained of how poorly managed the sales floors were and how long it took to get proper service.

We had no leader to turn to. None of us knew who was in charge at the top and no one seemed to care. People lost benefits, got demoted for lack of funding, lost pensions, and were even forced into early retirement because it was cheaper than keeping their position.

It appeared to be turning into chaos quickly, so I finally left to discover better opportunities. It makes me sad to think that such an historic company is on it's last leg. I gave it 5-10 years before it's gone when I left. I don't see that changing.

Point well taken on Stonewall Jackson--and what business doesn't need a Robert E. Lee, if only for the loyalty and devotion he inspired in his men and his lieutenants. But I'm afraid that even if his like was in charge of Sears, he would be ground down by Wal-Mart's Army of the Potomac as Lee was in 1864--they are relentless. And they're not led by John Pope or George McClellan. . .

You are dead on with this one! I have been a long time Sears customer....since I was 18 years old....over 30 years. I fell on hard times and had to close my account with Sears. It has taken me forever to pay it off and I no longer shop at Sears. The average card carries an interest rate of 23.5%. In Octber, when the 90 days Christmas sales begin, Sears automatically raises everyone to a 29.9% interest rate. Not much incentive for shopping the Christmas season and with the "layaway" programs gone, and a recession, buying large ticket items are nearly impossible. K-Mart is a favorite among shoppers, Sears would do well to remember that and maybe pickup some pointers like "blue-light specials" and impulse sales. BTW, I work for JC Penney's as an Sales Associate, so I tend to pay close attention to what I see working for the customer. Thanks for the great article!

Gordan Segal is a genius, but aside from his age, he would never get involved with a Sears. He founded C&B and among his genius moves: Never going public. He abhors running a public company because he never wanted to have to grow for the sake of growth to meet Wall Street's objectives. To him (based on what he told me in several interviews over the years) key is getting the RIGHT retail space, not just ANY retail space. Then creating a team, and opening new stores with managers/employees who know the biz. It has worked stunningly well for him. And I don't believe, from a wealth standpoint, he is any worse for wear by not going public. Instead, he sold a chunk of his company to a company from German or the Netherlands or somewhere in the vicinity! Smart, smart guy, you're right. Lots to be learned from him.

Hi Jeff, we met once after you gave your What Would Warren Buffet Do Speech on GE. Unfortunately for you it was a few days after Buffet put $3 billion to work in GE, thus answering your question.

I think much of what you are saying here is overly simplistic, and not very insightful to be honest. General? I think Eddie is looking for the right one vs. HomeDepot's value destroying General Nardelli. It's not easy to find great ones that aren't founders, but I'm sure he's looking and I hope he finds him.

In any case no doubt that Sears has issues, and like any company would benefit from an amazing general. That said, from all the spot checks I've done stores are improving in some cases incrementally in others more substantially. Website is very nice. Branding and product innovation are starting to happen. However to your reader's point about why isn't Lampert working both ends....he is. I think the most interesting story with Sears is the dealer stores. You should check a few out. That store base is growing at a solid clip while company stores are shut down. It looks like a prop co/op co model to me.

I think that Lampert's best point in his reply is that way too many ppl hyped up Sears in the beginning. Real, value creating turn arounds, if they happen, don't happen over night, and it won't be clear that it's happened until this recession abates.

Your points about capex are broadly speaking right, but keep in mind Walmart is spending capex on a huge and growing base of stores. Sear's capex has been roughly flat at $500 million a year on a shrinking base of company owned stores, so you can argue capex per sq ft. is incrementally increasing.

5 years out, I think Sears operates a large network of dealer stores, a smaller profitable base of company stores, a service network, a large online retailer, and is selling off or leasing some of its real estate. Maybe a $35billion topline with 5% ebita, ie $1.75billion against 115 million shares, or $15/share ebita.

I appreciate the article, but I must admit, and this is not specific to you or Sears, the quality of what's written and said gets more and more like Cramer daily. Remember that great Barrons' piece in early 2007 about dumping Berkshire and going into AIG! Neverming Laing or Balter's previous price targets for SHLD at $300 and $190 respectively....these guys like most are flavor of the month.

I volunteer at a local consumer referral service where we take consumer complaints and offer suggestions on how to solve their problems.

It is amazing how many complaints we get about Sears and their poor performance in servicing their appliances. It seems as if they are more concerned about selling the extended warranties rather than honoring them.

JAS: Your recollection of the presentation on GE was incomplete--perhaps I wasn't captivating enough.

The point of the speech was the Buffett did not acquire a large slug of GE stock outright, as he did with companies such as Coke, Gillette and Wells Fargo. Instead, he took a preferred with an enormous dividend, plus warrants.

As for your Sears analysis, it's quite delusional.

Sear's comp store sales might not look so horrible relative to other retailers this year, but they have been falling for years while the other companies were growing.

Specifically, Sear's 2Q comps were down 8.6%, following a 6.2% decline in 2008 and a 4.1% decline in 2007. The cumulative comp in those three years is -22%.

As for your notion that "Eddie is looking for the right one," well, there's no evidence of it, but let's hope so.

As you can see from the post following yours, there's a lot of work to do here.

I'm not sure why you chose the word delusional to describe my view. It's rather insulting. Even if you disagree, there are probably better words. It's ok though I can take it.

As for your GE preso, your guilty of revisionist history my friend. You commented at the very outset of your presentation that it had been prepared prior to Buffet's announcement on Oct. 1. You were slated to speak at VIC for several months. You mean to say that you waited until less than a week to come up with your presentation? I don't buy it. The other curious point to debunk your revisionist history is that Buffet has had for years and continues to hold a position in GE common. So anyway you slice it your presentation was and continues to be off the mark. The simple answer to what would Warren do was already answered. Still your points on GE were terrific, and I appreciated them.

As for delusional, I'm not in disagreement with the facts surrounding Sears's situation, simply the outcome. It may very well turn out that I am wrong, but I don't think delusional is the word I'd have chosen. I assume my view is shared by Mr. Lampert, Mr. Berkowitz, Mr. Miller, Ms. Piccola, and a few other reasonably bright people. Maybe wrong, but not delusional.

As for the anonymous volunteer poster, I'm absolutely certain that when you sell roughly 1 of every three appliances you'll get a lot of complaints. It's worth looking at sites like ripoffreports.com to see how Sear's indexes vs Target, Walmart, Conns, etc.

Targets SSS have also gone from deceleration to outright decline over the same period.

I personally prefer profit measures and specifically FCF. On this metric Sears is simply not measuring up. No argument there.

Certainly I'm no private investigator, so I can't find any fingerprints. The only smoking gun proof I have that Eddie is looking is....well Eddie. Check out his letter to shareholders. He talks about the search among other things.

JAS,Have you been on the Sears website or seriously followed what they are trying to do with it?The Long Tail effect of having a ton of skus with very little difference between them has made the website a cluttered S-L-O-W mess. The hacking just illustrated the issues of speed, loading, and too many skus. Worse, the prices are higher on most items than you would find at other sites(Amazon, Walmart, buy.com, etc) so someone searching for an item via a price comparison site would ignore Sears. I'd be curious as to their conversion rate.Besides the handful of poorly done commercials, Sears has not utilized its appliance market share to push the other departments, and by spreading Kenmore and Craftsman to Kmart they have cheapened the brand values. Don't get me wrong, there have several steps they have taken this year that show signs of life and I do think rumors of its demise are overstated. But they do lack a general and a vision and much of what they are doing comes across as very unfocused.Regarding your point reducing number of company stores in favor of dealerships seems odd considering they set out to do the opposite when the merger took place. I don't want to see Sears fail(or any major department store for that matter) as the past 2 years have been horrible for retailers across the country, and will be worse for consumers if we are all left with only Walmart or Amazon.

Since my "delusional" comments stock is up another 50%+. Kmart sss now up 2 quarters in a row, no Gen. Grant, I hope there's a follow up piece to this post which was jumping on the Barron's bandwagon with a $30 price target...stock is $103 today. Do you still think it drops to $30 from here? if so please explain/update thoughts on Lampert.

JAS: I apologize for using the term "delusional." It was unneccesary, and harsh to boot.

However, we never forecast stock prices here, so I'm not sure to whom you're talking about this "$30" price target on Sears.

For one thing, I never express opinions on stock moves, period. For another, and as I said in the original column, short term stock moves mean nothing in the long run history of a business.

I'm glad you've made 50% in Sears, but I would make an educated guess that the average highly shorted retailer is up at least 50% from that same period of time. Pier One, for example, is up 300%.

I'm also glad K-Mart's comps have stabilized, but so has the rest of the world. Based on the comp sales at other large retailers, Sears continues to forfeit market share, Eddie or no Eddie.

It's always worth following up a post as developments change, and I appreciate yours. Still, the rally in Sears doesn't seem to me to owe itself to the genius of Eddie: rising tides lift all boats, even the badly built ones.